Impact of Home Equity Theft Prevention

On July 26, 2006, Governor George Pataki signed into law the “Home Equity Theft Prevention Act” after unanimous votes in the New York State Assembly and Senate. The bill was sponsored by Assemblyman Darryl Towns and Senator Hugh Farley, chairs of the Banking Committees in their respective houses and shall take effect on February 7, 2007. The “Home Equity Theft Prevention Act” amends the banking law, the real property law and real property actions and proceedings law.[1]

While the intent of the new law is indeed just, to wit: To help protect homeowners from deed theft and “foreclosure rescue” scams which result in the loss of their homes and the equity they have built over the years in their homes[2], the act itself goes too far in many respects, and will create a situation where there will be many more foreclosures, increased bankruptcies, and create empty boarded up properties that are not maintained and are owned by out of state lenders. The intent of the law is supposedly not to prohibit genuine and fair offers of assistance, but rather to regulate the alarming number of homeowners who are swindled out of their homes by those investors who promise to help them out of foreclosure. Although at first glance it may seem that the Legislature has mounted an earnest attempt to protect innocent homeowners from losing their homes to certain predatory practices, the law in facts adversely impacts legitimate real estate investors, title companies, lenders, and homeowners as well.

[*] Thomas Weiss is the principal member and founding partner of the Law Offices of Thomas Weiss, P.C. in Mineola, New York and is a member of the Nassau County Bar Association real estate law committee and a member of the Long Island Real Estate Investment Association. and has significant experience in real estate matters.[**] Kafi J. Harris is an associate of the Firm.[1] The law amends New York State banking law, Section 595-a(1) by amending paragraphs (e), (f) and (g) (paragraphs (e) and (f) as added by chapter 571 of the laws of 1986, paragraph (g) as added by chapter 445 of the laws of 1990), and by adding paragraph (h). The law amends the real property law by adding section 265-a. The law amends the real property actions and proceedings law by adding section 1303.[2] See Bill No. S04744A, Sponsor Farley’s Memo.

Summary of the Law

All transactions between homeowners, classified as “equity sellers[3]”, and purchasers, referred to as “equity purchasers[4]”, are covered under the law. The law excludes from its definition those who purchase property to be used as their primary residence, lenders who have acquired the property through foreclosure proceedings or those who acquired a property through a referee sale, a transfer to a relative, the transfer to a non-profit or governmental housing organization and “bona fide purchasers[5]”.

The new bill mandates that transactions involving the sale of a home in foreclosure must be executed with a written contract that includes the terms of the title transfer and is written in the seller’s native language[6]. It gives the “seller” five days to cancel the transaction, requires that the sellers be given a written warning about deed theft scams, prohibits the purchaser from making false or misleading statements intended to defraud the homeowner either by misrepresentations regarding the value of the residence or misleading statements regarding the sale of the residence or the reconveyance agreement. Pursuant to the law, false or misleading statements could range from misleading statements regarding the value of the residence in foreclosure to misleading statements concerning the sale or reconveyance agreement[7]. Although such statements are listed in the law, they are extremely broad and neither explained or defined. Moreover, a purchaser does not have to knowingly or intentionally make misleading statements in order to violate this section of the law. Even so, criminal penalties for violations of same are harsh for even first time offenders.

[3] An equity seller is defined as a natural person who is a property owner or homeowner at the time of the equity sale. See Real Property Law § 265-a (f).[4] An equity purchaser is defined as any person who acquired title to any residence in foreclosure or, where applicable, default, or his or her representatives as defined in the law. See Real Property Law § 265-a(3).[5] Id. A bona fide purchaser constitutes anyone acting in good faith who purchases the residential real property from the equity purchaser for valuable consideration or provides the equity purchaser with a mortgage or provides a subsequent bona fide purchaser with a mortgage, provided that he or she had no notice of the equity seller’s continuing right to, or equity in, the property prior to the acquisition of title or encumbrance, or of any violation of this section by the equity purchaser as related to the subject property. See Real Property Law § 265-a(2). See also, Kristen Keefe, New York Passes the “Home Equity Theft Prevention Act,” Empire Justice Center (August 2006).[6] Real Property Law § 265-a(3) & (9).[7] Real Property Law § 265-a (7)(B)

In addition to this protection, the law also extends the seller the right to rescind the transaction for violation of sections three, four, six, seven or eleven of the law within two years of the date of the recordation of the conveyance[8]. If the seller elects to exercise his right of rescission he or she must give notice to the equity purchaser and upon receipt of said notice the equity purchaser has within twenty days in which to reconvey title that is free and clear of any and all encumbrances on the property[9]. Upon failure to reconvey the property within the allotted twenty days, the equity purchaser may be faced with legal action by the seller to enforce the rescission and cancellation of the covered contract and deed[10]. If the property has been sold to a bona-fide third party, a rescission on the part of the seller would not affect the third party’s interest and the seller’s sole remedy would be to pursue a claim for damages, including attorney’s fees and cost, against the equity purchaser[11].

Under the law, Sale-Leaseback Agreements[12] are deemed to be loan transactions[13]. In such an arrangement, the equity purchaser must verify that the seller has the ability to repurchase the property in accordance with the terms and conditions set forth in the Agreement before entering into the transaction[14]. If the equity purchaser desires to assign the agreement to a third-party, the seller must then sign off on any transfer of the property within the term set forth in the Agreements[15].

[8] Real Property Law § 265a (9)[9] Real Property Law § 265-a (8)[10] Id.[11] Id.[12] A Sale and Leaseback Agreement is an agreement in which the seller sells his home to a purchaser who immediately leases it back to the seller.[13] Real Property Law § 265-a (11)(A), See also, Id. at 5.[14] Real Property Law § 265-a (11)(B)(I)[15] Real Property Law § 265-a (11)(B)(III)

Lease and rental agreement terms during the re-conveyance must be “commercially fair and reasonable[16]”. However, what is “commercially fair and reasonable” is not defined within the statute. In the event that the seller is unable to repurchase the property at the end of the stated term, the seller is entitled to re-purchase at 82% of the fair market value rather than for full fair market value[17]. Although one would expect the determination for the fair market value to be for set forth on the date in which the property would be re-conveyed to the seller, under the Home Equity Theft Protection Act, such is not the case. The law sets forth several standards of how fair market value should be determined at this time. For example, the time for determining fair market value must be set at the time of the original contract in the re-conveyance agreement[18].

One of the most controversial parts of the law surrounds the issue of the “foreclosure notice.” To protect homeowners from becoming prey to those who promise to “rescue” them from foreclosures, the law mandates that the foreclosing parties must send a consumer education notice with the summons and complaint[19]. The notice must be placed on color paper and include in bold 14 font type and in the seller’s language, information warning the homeowner of potential investors who are likely to entice the owners into transactions with the promise that their homes will be saved[20]. The law also mandates that the New York State Banking Department is responsible for providing a telephone number and web address, and must make this information readily available for lenders[21].

Another controversial section concerns the criminal penalties used to punish potential violators of the law. An equity purchaser can be held criminally liable for “knowingly” violating particular sections of the law[22]. Pursuant to the Act, an equity purchaser may be in violation of the law for simply failing to attach a notice regarding cancellation to the Contract of Sale[23]. Other violations include failing to include certain terms in the contracts, entering into re-conveyance arrangements that are not in accordance with this law or even assisting the seller in preventing a completed foreclosure[24]. For first time “offenders” of the law, penalties include a fine of up to twenty-five thousand ($25,000) dollars and/or imprisonment of up to one year in jail or both[25].

The Negative Impact of the Law

While it is true that some homeowners lose their homes to unscrupulous investors, the truth of the matter is that this law goes far afield and thereby creates a frightening precedent of governmental interference with business practices. When a homeowner is facing the possibility of losing his or her home as a result of foreclosure, he or she has every right to do everything he or she can to save it – negotiate with the lender, make back payments, try to refinance his or her home, or even sell the home. The passing of this law does not only serve to virtually eliminate these options, but it also has the potential to increase the number of bankruptcies that are filed.

One of the major problems with the law concerns that of the two year extended right to rescission of the contract. The law threatens the stability of titles by requiring the title companies to perform substantial searches into whether a rescission notice was given and if it was in fact affected and the method of delivery. Since, under the law, the contract notice survives any transfer of the property, litigation involving deed delivery disputes will potentially arise and overwhelm our already congested court system[26]. Consequently, title companies will be forced to create exceptions into their policies when insuring these foreclosures. As a result, many title companies will be unwilling to insure against the risk that someone in the chain of title may have the right to rescind under the legislation.

For a potential homeowner, the impairment to the title companies will also bear negatively on him as well. Without title insurance, many lenders will be hesitant to allow purchasers to obtain financing. On the other hand, if the homeowner is able to obtain financing, but then loses his home to an equity seller in a rescission suit, he will be burdened with the significant loss, including the loss of his home, ongoing liability for any financing he or she obtained to purchase the home, litigation costs; and loss of any improvements in the home. Although it may be argued that the law does not apply to those who are “bona fide purchasers” of a home in foreclosure, with the law’s narrow definitions of such a purchaser coupled with the ambiguity of who is in fact considered same, the law leaves many purchasers unprotected and vulnerable to litigation.

For the lender, this law creates a problematic situation in which the lender is subject to additional expenses prior to and potentially even after extending a loan to the purchaser. One of the affects of the law was to amend section 595-a of the Banking Law. In accordance with this amended section, a lender is held in violation of the Banking Law if it “had knowledge that the equity purchaser was not complying with the provisions of section two hundred sixty-five of the real property law with respect to such transaction[27]”. In order for it to not violate this section of the Banking Law, a lender must now take on the additional duties of having to verify whether or not the purchaser complied with each and every section of the Home Equity Theft Protection Act, a n overwhelming responsibility that it was never required to do before and is not familiar with. If the lender does indeed extend a mortgage to a purchaser, in the event that there is a rescission of the contract, the lender will be faced with the risk that it may not be able to recoup all the funds that it lent out. For example, given that the property must be given to the seller “free and clear of all encumbrances” upon recession of the contract, the lender loses its security interest in the home and must look to the borrower for repayment. If the borrower is unable to pay the difference between amount lent and what was returned back to the lender upon rescission, the lender will run the risk of losing funds.

[26] See Committee on Real Property Law of the Association of the Bar of the City of New York disapproval of Senate Bill No. 4744 and Assembly Bill 7667.[27] Banking Law § 595-2(h)

With respect to the foreclosure notice, there is no evidence that borrowers facing foreclosure are in need of any additional notices. The Home Equity Theft Protection Act ignores the fact that a majority of the mortgage lenders in New York already require that loan services send out similar notices to borrowers facing foreclosure. These notices, similar to the notice required by the Home Equity Theft Prevention Act, give the borrowers ample information about their rights and options and where to go for help. These notices already protect the borrowers from being victimized by predatory investors. As set forth in a New York State Bar Association Memorandum in Opposition against the law, “[c]ommunity organizations do not have the ability to work out a loan; this is something reserved to the mortgage lenders/services themselves. There are no governmental agencies or organizations that are allowed to give legal advice about foreclosure[28]”. By referring borrowers to contact agencies, such as the New York State Banking Department, rather than the lenders itself, the law becomes a hindrance rather than an aide for most foreclosure owners. Moreover, in requiring that foreclosing parties must supply homeowners with the proposed notice with a summons and complaint will only serve to diminish the seriousness of the proceedings and mislead a borrower into believing that he does not have to answer the complaint.

No one can afford the risk entering into transactions of buying a home that can arbitrarily be rescinded within the two years after the purchase or can subject them to penalties as severe as one year in jail. Although the intent of the legislation is justifiable, the law tends to stifle those investors who legitimately help to maintain our already fragile economic market. It also serves to punish those who legitimately purchase a home by creating a risk that they will have to bear the expenses of financing a home that they no longer own. The fact of matter still remains that several homeowners will eventually end up in foreclosure proceedings. Thus, where the law might potentially protect a person from deeding over his home to a corrupt investor; it does not ultimately protect him from losing his home through foreclosure.